Minutes from the Fed were downbeat on inflation and the economy—as was widely expected.
Markets fought higher after beginning the day down, perhaps on speculation more monetary easing is on the horizon.
The current climate seems to favor Fed action in some form.
Of course—though commentators seem to be taking it as a given—the Fed hasn't done anything yet.
Ever eager to tie economic events to market moves, investors devoured the Fed's minutes from its recent policy meeting Tuesday. The report was downbeat on inflation and the economy—as was widely expected.
Fed officials noted inflation (1.4% y/y in August, ex. energy and food) is running below its target 1.7% - 2.0% range. (Though we'd note, it's not that far off.) They further lowered their economic and inflation forecast for the remainder of the year and into 2011. Markets fought higher, after beginning the day down. The S&P 500 closed up 0.4%.
Why did a downbeat report make markets happy? Investors may have taken the report to confirm suspicions the Fed will expand asset purchases (quantitative easing) in November. Though Fed officials said they didn't expect another recession, they worried unemployment was running too high—a fear that likely wasn't assuaged by the most recent employment data—and discussed a plan that would allow them to target inflation higher than 2% after abnormally low periods.
There's no doubt the Fed is worried (that's their job after all). What's the likelihood they act on that worry come November? The current climate seems to favor Fed action in some form. Post-crisis, we think the Fed's done a pretty good job—adjusting policy to suit conditions—and current policy remains appropriate.
While more easing may be a good move, there is already plenty of liquidity in the system, and there may be no need for more. However, given low inflation and moderate growth the Fed may have a bit of a cushion to act. And while quantitative easing may not be needed, neither will it be overly harmful.
Of course—though commentators seem to be taking it as a given—the Fed hasn't done anything yet. It could be conditions no longer warrant action next month. Or with elections in the rearview, there's less pressure to appear willing to fight unemployment (ever present on voters' minds).